The Crude Oil Export Ban - "What, Me Worry About Peak Oil?"

Congress ended the U.S. crude oil export ban last week. There is apparently no longer a strategic reason to conserve oil because shale production has made American great again. At least, that’s narrative that reality-averse politicians and their bases prefer.

The 1975 Energy Policy and Conservation Act (EPCA) that banned crude oil export was the closest thing to an energy policy that the United States has ever had. The law was passed after the price of oil increased in one month (January 1974) from $21 to $51 per barrel (2015 dollars) because of the Arab Oil Embargo.

The EPCA not only banned the export of crude oil but also established the Strategic Petroleum Reserve. Both measures were intended to keep more oil at home in order to make the U.S. less dependent on imported oil. A 55 mile-per-hour national speed limit was established to force conservation, and the International Energy Agency (IEA) was founded to better monitor and predict global oil supply and demand trends.

Above all, the export ban acknowledged that declining domestic supply and increased imports had made the country vulnerable to economic disruption. Its repeal last week suggests that there is no longer any risk associated with dependence on foreign oil.

What, Me Worry?

The tight oil revolution has returned U.S. crude oil production almost to its 1970 peak of 10 million barrels per day (mmbpd) and imports have been falling for the last decade (Figure 1).

It’s not important whether this is the final, maximum world production peak or not. It is a signal about a trend that needs to be acknowledged and incorporated into our evolving paradigm about oil supply.

Peak oil production was accelerated by a confluence of factors. Zero interest rates in the U.S. and Middle East supply interruptions before 2014 caused high oil prices. Easy money caused over-investment in the oil business. Over-production and weakened demand resulted in the collapse in world oil prices. OPEC’s reaction and decision to produce at maximum rates have created the “perfect storm” for peak oil production several years before it would have occurred otherwise.

All oil producers are losing money at current prices but companies and countries are producing at high rates. Indebted conventional and unconventional players need cash flow to service debt so they are producing at high rates. OPEC is producing at high rates to maintain or gain market share. Everyone is acting rationally from their own perspective but from a high level, it looks like they have all lost their minds.

Peak oil is not about running out of oil. It is about what happens when the supply of conventional oil begins to decline. Once this happens, higher-cost, lower-quality sources of oil become increasingly necessary to meet global demand.

Figure 4 is from Schlumberger, a company that knows the costs of its global customers. It shows that tight oil is the most expensive source of oil, followed by deep-water and other offshore oil. Conventional oil from onshore and OPEC middle eastern sources is the lowest cost oil.

Schlumberger did not include oil sands in its chart because it is difficult to compare the costs of a manufacturing operation to the cost of drilling individual wells. Existing mined and SAGD oil sands projects, however, break-even at approximately $50 per barrel although new SAGD projects require about $80 per barrel.

The principal tight oil plays–Bakken, Eagle Ford and Permian basin–break even at $65 to $70 per barrel oil price today.

Table 2. Key operator weighted-average estimated ultimate recoveries (EUR) in barrels of oil equivalent and break-even oil prices. Drilling and completion (D&C) costs used in the economic calculations are shown. Economics also include an 8% discount. Details may be found at the following links: Bakken, Eagle Ford and Permian.

Source: Drilling Info & Labyrinth Consulting Services, Inc.

(Click image to enlarge)

Although EUR is higher and break-even prices are lower for certain operators and core areas of the plays, Table 2 reflects representative average values for operators with the highest rates and cumulative production. If the price of oil increases, service costs will also increase and the production cost will be higher. Efficiency gains are largely behind us as new well production per rig has flattened in the last quarter of 2015 (Figure 5) so it is unreasonable to expect costs to decrease much further.

The economics of tight oil plays require spot oil prices that are double and wellhead prices that are triple current face values. Excluding new SAGD projects, tight oil is the world’s most-expensive and, therefore, marginal barrel of oil and its cost of production today is more than $70.

Perception is Everything

Congress’ decision to lift the 40-year U.S. ban on crude oil exports reflects the same misinformed and distorted thinking that declares that the world’s highest cost producer - tight oil - can somehow also be the world’s swing producer.

The 1975 export ban was enacted because of the disastrous economic consequences of becoming dependent on imports following the peaking of U.S. oil production in 1970. Now that oil production is again close to peak levels, we have apparently forgotten that imports were the problem then and that we import twice as much today as in 1975.

The same thinking concludes that because oil markets are over-supplied by about 1.5 mmbpd today, prices will remain low for years if not decades. Although there is certainly a rationale for low prices based on fundamentals of supply and demand in the near term, the longer view is shaped largely by perception.

Oil prices (Brent) rallied, after all, to $65 per barrel in May when the market was more over-supplied (2.25 mmbpd) than it is today. That was based on perception that falling rig counts in the United States and withdrawals from oil-storage inventories would bring less supply. Neither perception was correct in the short term but it didn’t matter. Prices rose. There were, of course, other factors including concerns about the growth of the Chinese economy, the Greek debt crisis, and renewed Iranian exports.

Despite the recent trend toward price capitulation since late November, there is a certain potential energy in the market to find excuses to raise prices or to at least establish a bottom. For example, this week, U.S. crude oil stocks declined by 5 mm barrels and WTI futures increased $3.36 per barrel. We are in the winter de-stocking period so a withdrawal from inventory is normal but the previous week saw an addition to stocks that made this withdrawal seem somehow more important. A price increase of that magnitude makes no sense especially since U.S. stocks are more than 125 mm barrels above the 5-year average. That is the power of perception.

Energy and oil in particular underlie everything in our global economic lives. Oil prices reflect our collective emotional response to the circumstances of the world. Fundamentals are the vital signs of oil price’s body but perception is the key to its psyche.

The more-than $3 per barrel increase in WTI prices last week is an example of a very short-term reaction to some event or circumstance. Oil prices also reflect longer-term longer term price responses that involve considerable lags. For instance, a global production surplus appeared in January 2014 and continued for 6 months before prices responded downward.

Climate change and peak oil are long-term perspectives that many prefer not to think about or to reject as frauds. That is because they force us to consider that there may be real limits to growth. That is anathema to the economic and cultural paradigm that much of the world embraces. They suggest that energy will cost more and that we may have to live with less in the future than we have in the past. That means extreme changes in both our behavior and our expectations.

The prevailing perspective–lower for longer–is that oil prices will remain low for many years.

This is reasonable based on vital signs. The global over-supply of oil persists after a year-and-a-half of lower prices. Iran and Libya could potentially add another 1-2 mmbpd to the existing over-supply. U.S. production has not declined as much as most experts anticipated, and there is considerable if unknown spare capacity in drilled, uncompleted wells. China’s economic growth has slowed and the global economy is weak. Demand for oil will continue to grow but at a slower rate than in 2015.

What Lies Ahead in 2016

In another week, the world will go back to work after the holidays. The bleeding in the oil patch will get worse and prices will plunge again. Year-end results for oil and gas companies will be the worst so far. The Federal Reserve Bank and Standard & Poor’s have issued warnings about bad debt in the U.S. oil and gas business. The tight oil companies have put the best face they can on a desperate situation.

But investors and their bankers should be out of patience. They should be tired of phony economics and tall tales about giant new reserves when the companies they invested in are losing billions of dollars every quarter.

The lower-for-longer perception will begin to change in 2016 barring a global economic collapse. It is, after all, founded on the simultaneous occurrence of every possible negative outcome. The long-awaited response in the economy to lower oil prices will begin to emerge. Demand for oil will increase. Concern about lower growth in China is largely accepted already. U.S. production will continue to fall 100,000 barrels per day every month as predicted, just later than expected. Drilled uncompleted wells will not deliver as much new oil as many now fear.

None of this will happen overnight. Market balance will likely return more slowly than it unravelled. The oil bubble took 5 years to inflate but the world is impatient and expects a quick return to normal. All of the signs are right–lower rig counts, distress for overly leveraged companies, lower budgets for crucial exploration and development projects–but it all takes time.

Energy is the economy. Lower oil and gas prices will be a huge benefit to the global economy but that takes time also. And the longer prices are low the better, although it doesn’t feel that way in the oil business right now.

Tight oil has bought the U.S. another decade or so of additional oil supply but, as peak oil predicted, at a cost. The technology behind tight oil has also made it the world’s most expensive barrel. As all of this sinks in, perception will start to change. Analysts and investors will begin to see that data points more toward long-term scarcity than toward long-term abundance of oil supply.

The U.S. is far more economically vulnerable and dependent on foreign oil today than when crude oil export was banned 40 years ago. The world has finite oil resources and the production party of the last 5 years has accelerated the timing of peak global production. A shooting war in the world would bring all of this into instantaneous focus if the data presented here has not.

It is a curious paradox that peak oil should manifest in the midst of over-supply and low oil prices. That is certainly not how I thought things would happen. Perceptions will change and oil-market balance will be restored in ways that few of us thought likely. Peak oil will be part of that change.